Reader Question: “What happens to the dividends paid on stocks held in mutual funds? Are they kept by the fund, or used to buy more stocks in that company? This is a huge amount of money going somewhere. Could you please explain where all that money goes?” – Roger

 

 

The Short Answer: Dividends are paid to a company’s shareholders, which very often include mutual fund investors. All the earnings of mutual funds, including dividends, interest, and capital gains, belong to the shareholders of the mutual fund. Dividends can be distributed to them in one of two ways. The dividend could be added to a “cash” account within their portfolio (a money market account, for example) or it could be reinvested in the mutual fund. The only money kept by the mutual fund are the fees (which are disclosed in its prospectus). Let’s take a closer look at fees and how they are calculated:

 

The Fund Fees: The fees charged by mutual funds are expressed as an annual percentage and referred to as the “expense ratio.” While the average annual fee charged by mutual funds is 1.5% (according to Lipper), the cost of individual mutual funds can vary widely. You will never see fund fees presented on your brokerage statement or trade confirmation. Thus, many investors don’t realize the true cost of their mutual funds because: 1. the fees are deducted daily and 2. they are deducted directly from the fund at the close of the business day (before the final value of the fund is determined).

 

Example: If we take that average mutual fund fee of 1.5% and divide it by 252 business days, the charge applied each day is only .006%. That doesn’t sound like much, but let’s put it into dollars by assuming a $100,000 investment. Based on that amount, the fund would charge $5.95 a day. Multiplied by 252 business days, you have an annual cost of $1,500. That $5.95 is going to come out of the fund each day before you see the closing value, and it’s going to fluctuate with the value of the fund; if the fund increases from $100,000 to $110,000, the fee being deducted will increase to $6.55.

 

Worth It? My concern is that a lot of people who own mutual funds (and variable annuities) don’t know how much they are paying in fees. 1.5% is not a high fee, and don’t get me wrong, I like mutual funds, especially no-load funds and ETFs. I’m just saying you need to know what you pay in mutual fund fees so you can evaluate how much “bang you are getting for your buck.”